Choice for Tight Times: Save More or More Risk

Conrad De Aenlle

Thursday, 14 Mar 2013 | 9:24 AM ETThe New York Times

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Troels Graugaard | E+ | Getty Images

Building an investment portfolio that produces enough income to live on is one of the main goals of retirement planning, but lately the goal posts have shifted. With interest rates stuck near record lows, retirees must have more saved up to produce the same income through the usual high-quality investments, like Treasury bonds, or else they must venture into assets with higher yields but potentially higher risk

An alternative approach that financial advisers increasingly find appealing is to replace lost income with greater flexibility. Instead of seeking to generate more income, they say, investors should acquire a mix of assets that can produce greater total return — income plus capital growth — from which to finance retirement needs.

"Investors have to look beyond the old strategy and realize that they're being constrained by the idea that they should never sell principal," said David Kelly, chief market strategist at J. P. Morgan Funds. "They should take systematic withdrawals from their portfolio, whether they come from dividend income, coupon payments or from selling appreciated growth stocks."

If that seems like a risky proposition — what if growth stocks depreciate? — Lex Zaharoff, head of the Investment Lab at Citi Private Bank, an in-house portfolio analysis group, suggests that a heavy concentration in bonds comes with its own hazards, starting with a lack of diversification.

"The danger of being overly focused on boosting yields is that some investors fall into the trap of boosting yields by a single dimension," he said. "If they own longer-dated bonds, they're taking on risk if rates go up suddenly."

What can make a fixation on income especially risky nowadays is that while many advisers have begun to take a more "holistic, multidimensional approach," Mr. Zaharoff said, the quest for income by others with a more traditional approach has pushed prices too high and yields too low on many investments. "Valuations matter," he said.

They also matter to Christopher M. Zelesnick, senior managing director at Ziegler Wealth Management in Chicago, who likewise finds few palatable options among income-producing assets. He considers it sensible to own high-yield corporate bonds, for instance, in anticipation of rising interest rates and an economic revival, the sort of backdrop that is anathema to Treasury issues, but lofty valuations are putting him off.

"High-yield bonds perform well if the economy is improving," he said. "The problem today is that a lot of investors have run to that side of the fence and lowered yields below where they should be."

Jordan Waxman, managing director of the financial advisory firm HighTower in New York, acknowledges that decent income is harder to achieve. Yet he detects it in enough corners of the markets, and with acceptable levels of risk, for retirees to avoid having to dip into their capital.

"With the caveat that you can't squeeze blood from a stone," he said, "I would be in the camp that you should secure cash flow from investments to the extent that you can do that. There are areas that might be overlooked that can still get you where you need to go."

The destination he has in mind is an average yield of 5 to 6 percent. His preferred vehicles include two that offer tax advantages that inflate investors' net yields: high-yield municipal bonds and master limited partnerships, which are businesses engaged mainly in oil and gas transportation — the type of partnerships he favors — and production.

Mr. Waxman also likes blue-chip stocks that pay big dividends. If that seems like a perilous choice with the stock market at multiyear highs, he points out that different kinds of stocks have enjoyed the rally to different degrees.

"The stock market has had a very nice recovery led by low-quality companies," he said. "Most financially stable, rock-solid companies have not participated as much. Prices are similar to where they were 13 years ago."

Higher-yielding stocks are a popular choice among investment advisers, whichever retirement-planning philosophy they adhere to, because they allow investors to have their cake and eat it, too.

"Dividend-paying stocks have yields close to 10-year Treasury yields, and in addition they have growth prospects," Mr. Zelesnick said. "As a business does better it can increase its dividend."

Mr. Zaharoff is a fan of stocks with healthy yields, too, particularly "well-regarded global companies that have strong franchises and plenty of cash," he said. "You want companies to be growing profitably and choosing to distribute some of that back in dividends."

When trying to find the right mix of assets to produce a suitable mix of income and growth, investment advisers recommend using a professional because of the need to juggle the various market niches along with the needs and wants of investors. Which sort of professional is best depends on the approach an investor wants to take.

"There are two approaches," Mr. Kelly said. "Work with a financial adviser to put together an appropriate portfolio, explaining what your risk tolerances and income needs are, and let the adviser figure out whether you're going to be selling assets to derive that income. Another way to go is to buy a broad asset-allocation mutual fund and set it up to take withdrawals every month."

He considers a global income fund, with holdings in many markets and asset classes, to be a particularly good option, but he stresses to investors that how they put their money into the markets has nothing to do with how they take it back out.

"They should separate the distribution part from the strategic-allocation part," Mr. Kelly said. "They're two separate issues. People often get them confused."